New Transfer Pricing Development
in China
Overview
Recently the Chinese tax authorities have started investigating
and auditing transfer pricing policies of FIEs conducting
inter-company transactions. The State Administration of Taxation
(SAT) recently issued Circular 370 to all the subordinate
tax bureaus on the various aspects of anti-avoidance/transfer
pricing audit to be undertaken in 2004. Before this, circular
70 was issued on June 9, 2004 aimed at strengthening transfer
pricing enforcement efforts nationwide. The circulars provide
clear evidence and measures that the SAT has become increasingly
sophisticated in the transfer pricing area since Circular
[1998] 59, which contains China's transfer pricing rules,
was issued.
This is predominately due to the fact that many FIEs use
transfer pricing to realize profits offshore and for avoiding
taxation. The development of the Chinese transfer pricing
laws and regulations were formulated largely on the recommendations
set out by the Organization for Economic Cooperation and Development
(OECD). According to Article 9 of the OECD Model, the "arm's
length principle" is defined as "Where conditions
are made or imposed between the two enterprises in their commercial
or financial relations which differ from those which would
be made between independent enterprises, then any profits
which would, but for those conditions, have accrued to one
of the enterprises, but by reason of those conditions, have
not so accrued, may be included in the profits of that enterprise
and taxed accordingly".
Information Sharing and Use
There will be greater co-operation among tax officials in-charge
of anti-avoidance audits in different locations. For example,
tax officials in different locations would share information
on high-risk taxpayers and provide to the SAT suggested targets
for national joint transfer pricing audits.
The anti-avoidance tax officials are also required to share
information with tax officials in-charge of other taxation
such as income tax, turnover tax and customs, and other regulatory
bodies, e.g. Ministry of Commerce, Administration of Industry
and Commerce, etc.
Filing requirements
When related parties transactions (RPT) occur, the taxpayer
has an obligation to submit a declaration form. If there is
only one category of transaction with the related party, declaration
form A should be submitted. This should be completed on an
annual basis and returned to the tax authorities within four
months of the end of the tax year. Where there is more than
one category of RPT conducted, form B should be submitted.
If the form cannot be filed within the stated time limit,
an extension should be applied for to the tax authorities.
The maximum postponement of filing the declaration form is
30 days. If the taxpayer fails to submit the declaration form
within the time limit (i.e. 30days), then a new limit may
be set, but a fine of up to RMB 2,000 will be imposed. A fine
of RMB 2,000 - 10,000 will be imposed for application of further
postponement according to Article 62 under <Law of the
PRC Concerning the Administration of Tax Collection, Order
[2001], No.49 of the President of the PRC>.
Document requirements
There are no statutory requirements for documentation to
be submitted apart from the abovementioned proforma. Based
on practical experience, the following principal documentation
is usually requested by the tax authorities. This documentation
should be continuously updated where required.
Compensatory adjustments
After a transfer pricing investigation has been completed,
the tax authorities may adjust the relevant taxable amount
if it is deemed that the RPT does not abide by the "arm's
length" principles. The adjustments may be based on the
following four (4) principles including: the pricing of the
same or similar business transactions between unaffiliated
enterprises (uncontrolled transactions method), the profit
margin obtainable if the goods were resold to a non-affiliated
party (resale price method), the cost plus a mark-up% (cost-plus
method) and other reasonable methods (non-specified methods).
Penalties
There are no specific penalties detailed in taxation laws
or regulations. However, if the taxpayer has any tax payable,
resulting from a transfer pricing investigation, the taxpayer
must settle the payment within the time limit prescribed by
the authorities. If the taxpayer fails to do so within the
time limit, a surcharge of 0.05% per day will be imposed.
For serious violations, the taxpayer may face tax penalties
of up to five (5) times the amount of understated taxation.
Special circumstance affecting the period of tax audit investigation
In April 2003, the State Administration of Taxation ("SAT")
issued (Guoshuifa (2003) No. 47), which extended the transfer
pricing adjustment period to 3 years or under special circumstances
up to ten years. Special circumstances were then defined as:
